11/12/2009 @ 11:20PM

Silicon Valley Learns How To Play Hockey

Venture capitalist Kevin Compton takes the same approach to the San Jose Sharks as he does to any of his Silicon Valley investments: no entitlements. He pays for his own tickets and food at games. He has yet to take a penny out of the team, which ended last season with the best record in hockey. Compton doesn’t mind funding the team’s losses, but he expects Sharks management to turn them into a winner off the ice, too.

That they will. While bad news engulfs several of the other franchises that emerged from the National Hockey League’s 1990s expansion into warm-weather markets, the Sharks are looking like one of the best-managed teams in the sport. Seven years ago Compton led a group that, according to sports bankers, paid $80 million and assumed $45 million in debt for an 85% stake in the team, implying a total value of $147 million. (Compton says his investors put up less but won’t give particulars.) The Sharks now have an enterprise value FORBES estimates at $184 million.

Sharks ownership got it right by keeping debt manageable and using the team’s experience in hockey to move into other high-growth sports businesses. Contrast that to the Phoenix Coyotes, which filed for bankruptcy last spring, a victim of bubble real estate deals around their arena. A highly leveraged balance sheet also battered the Tampa Bay Lightning. The Sharks’ approach has created a blueprint for how an organization can make money in what the league calls a “nontraditional hockey market.”

The Sharks are merely one division of a parent company called Silicon Valley Sports & Entertainment. Of SVSE’s revenue of $155 million, NHL hockey brings in $84 million. The rest comes from things like a chain of ice rinks, three professional tennis tournaments, a mixed martial arts circuit and an apparel company. Last year the team’s hockey operations lost $5 million, but the profits from the other businesses cut that loss to an estimated $2 million. Gregory Jamison, a Sharks co-owner who’s in charge of day-to-day operations, sees the combined businesses turning a profit in two to three years.

Rather than borrow to fund the team’s operating losses (a cumulative $20 million since 2002) and expand into new businesses, the owners issue capital calls to the limited partners, just as a venture capital firm would do. The organization picks growth areas that are not capital-intensive and that make use of existing staff and infrastructure.

The team’s use of its 16-year-old arena, the HP Pavilion, is a perfect example. Taxpayers underwrote 82% of the $163 million construction cost and ceded year-round control of it to the Sharks in exchange for a fixed annual payment, currently $5.7 million. The number of nonhockey events there averages 130 a year, making the Sharks proprietors of the fourth-busiest concert venue in the country. Nonhockey events at the arena added $8 million to the team’s coffers last year. Says William Daly, the NHL’s deputy commissioner: “In terms of leveraging the hockey team to create other business opportunities, they’re a prime model.”

The Sharks’ owners have been pursuing a National Basketball Association franchise for years, too. San Jose Mayor Chuck R. Reed tells FORBES that the arena lease will be amended this month to outline contingencies in case their efforts are successful. The group is also in discussions with the owners of baseball’s Oakland A’s to find common ground on a proposed ballpark in the area and to possibly buy into their Major League Soccer team, the San Jose Earthquakes. Even without these acquisitions SVSE officials expect the nonhockey side of the business to surpass the hockey side next year.

Jamison, 59, has been with the team for 16 years, after spending 13 in the front office of basketball’s Dallas Mavericks and Indiana Pacers. In 2002 he turned to Compton to form a group to buy the team from George and Gordon Gund. The Gund brothers were committed to keeping the team in San Jose and were looking for buyers who lived in the area.

Compton fit the bill. A sports stat geek, Compton, 51, made his fortune as a partner at Kleiner Perkins Caufield & Byers, a venture firm that early on backed the likes of
Sun Microsystems
,
Amazon
and
Google
and has raised $3 billion in capital since 2000. He would have the patience to stomach early losses and shy away from borrowing, and have enough going on elsewhere to let the Sharks run without much interference. He also had a thick Rolodex, which Jamison and Compton used to recruit ten other Silicon Valley power brokers, including former
Yahoo
financial chief Gary Valenzuela and past San Jose mayor Thomas McEnery, to form the new ownership group.

Their first year was dismal. Sponsors and ticket holders were still reeling from the burst tech bubble. Things weren’t much better on the ice, where the Sharks missed the playoffs for the first time in six years. Season ticket subscriptions dropped from 14,000 to 11,500, and the value of the team (as we measure it) fell 13%. The owners sacked general manager Dean Lombardi and replaced him with Douglas Wilson, who played on the Sharks’ inaugural squad in 1991 but had never run a team.

It was during this slump that Compton had his eureka moment: The Sharks didn’t have to be just a hockey team. “There’s only 17,500 seats, and no matter what we do, we’re not going to sell 17,501,” he says. His answer was to enter or build upon businesses that looked and felt the same to the Sharks’ managers. They’ve done just that, expanding at breakneck speed ever since. “It’s venture capital’s grow-or-die mentality,” he says.

In 2003 SVSE converted the Sharks’ embroidery business into a full-scale merchandising company that produces logoed golf balls and bumper stickers for the likes of
Lockheed Martin
and
Cisco
. Its publishing division, which puts together game programs and media guides, counts the National Football League’s Oakland Raiders and San Francisco 49ers as clients, as well as Santa Clara University.

The next year SVSE began expanding and remodeling the Sharks’ skating rink business in three northern California cities. Its rink in San Jose was already the largest west of the Mississippi, with 3,000 registered skaters who pay up to $8 per visit for admission. (Visitors include Compton, who slips on a jersey and plays hockey there anonymously twice a week.)

In 2007 the Sharks outmaneuvered the New York Islanders to gain the first NHL foothold in China, when they joined with the Chinese government to create a hockey development program. Although the venture in China is SVSE’s only ancillary business not currently making money, it’s viewed within the organization as a long-term investment.

In May 2008 SVSE acquired a 50% position in cage-fighting outfit Strikeforce. Since then revenue for the fighting operation has shot up tenfold to an estimated $30 million. Thanks to the credibility and broadcast experience of the Sharks’ owners, Strikeforce’s fights will now move from a 2 a.m. time slot on NBC to prime time on CBS and Showtime. The TV deal, signed in February, would not have happened without the Sharks on board, says Strikeforce founder Scott Coker. Four months after investing in Strikeforce, SVSE acquired two professional tennis tournaments in Memphis, Tenn. Those are run by the same tennis management staff that operates a popular men’s event at the HP Pavilion in San Jose.

Still, NHL hockey remains the linchpin, and success on the ice attracts fans and sponsors to the building, exposing them to all the other offerings. After general manager Wilson arrived, he blended traditional scouting with new types of analytics to build successful teams within the salary-cap limits introduced in 2005. Since then the Sharks, who’ve traded for veteran stars Joe Thornton and Dany Heatley and developed homegrown talent like forward Devin Setoguchi, have ranked first in the league in a comparison of wins to player costs (see www.forbes.com/nhl).

Season ticket sales have climbed back to 14,000, and 93% of ticket holders renewed for this season despite the recession. The Sharks have sold out their first five home games this season, bringing their number of sellouts to 39 in a row.

Add it all up and Jamison expects the Sharks to soon become self-sustaining, meaning: no more capital calls. Says Marc Ganis, a Chicago sports business consultant: “The Sharks are the prototype for how the NHL should operate in a nontraditional market.” Jamison has just one problem with that. Now that the Sharks have spent 18 years building their brand on and off the ice, “I don’t think we’re a nontraditional hockey market anymore,” he says. “We’re a hockey market.”